Macrovision fends off video pirates

CBS.MarketWatch.com

SUNNYVALE, Calif. (CBS.MW) Keeping would-be pirates from duplicating movies and computer games can have bolster effects on share prices.

Just ask Macrovision, a Sunnyvale, Calif.-based copy protection technology company. Since September, shares in this MicroCap company
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have doubled, and the incline has been particularly steep since April 27 when the company reported first-quarter earnings of 20 cents per share, nearly 20 percent ahead of the average estimate of analysts polled by First Call.

We spoke to Macrovision?s president and chief operating officer Bill Krepick about the surge in business.

First of all, can you briefly describe what Macrovision does?

We?re in all types of intellectual property protection. Our core business is specifically in the video copy protection area, which covers videocassettes, digital video discs, and digital pay per view. Recently, we expanded into computer software copy protection, going after the open PC games markets.

How do you protect against copying?

On the videocassettes, we embed electronically a signal throughout the videocassette that upsets the recording circuit in a VCR. In the case of digital pay per view or digital video discs, we embed an integrated circuit within the DVD player or digital set-top recorder that can later be activated by copy protection control codes in the video program or pay-per-view network access control system.

How do you earn revenue?

In case of videocassettes, we get per-unit royalties from the studios -- the rights owners. In the case of pay per view, we get a hardware royalty from the guys who manufacture the set-top boxes. We get that on a per-unit basis, but then we also reserve the right to license the actual use of the technology to people like Direct TV or Echostar -- the guys who actually operate the networks.

What has spurred the recent revenue growth?

In the sort of slow-growth videocassette business, our business has grown dramatically in the past year as we?ve added studios such as Paramount (a unit of Viacom
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), Dreamworks, Polygram (a unit of Seagram
VO, +0.01%
), and Columbia TriStar (a unit of Sony
SNE, +0.82%
). It seems that the added attention to copy protection brought upon by digital has caused people to think more about also copy-protecting their videocassettes.

DVD market

Then there?s the DVD market itself which, starting with last Christmas, has been on a phenomenal growth rate. We benefit because we?re in the infrastructure, we?re in 100 percent of the DVD players.

One-hundred percent?

Yes, and in the pay-per-view area, where industry statistics show that the deployment of digital set tops is running at a very high 25 percent per year growth rate, we?re currently in 17 million boxes out of the 20 million that have been deployed so far. So we have about a 90 percent penetration rate.

How have you achieved such high penetration rates?

We basically decided we would get relatively low royalties from the hardware guys, allowing us tremendous penetration within the hardware, and get the bulk of our business from licensing the use of the technology. We can go to the rights owners and say, "We are deployed in all the hardware out there, so when you sign with us on a per-disc or per pay-per-view movie, you?re getting this protection net around the world."

And studios and per-per-view operators are concerned about copy protection?

Yes, especially with the emergence of digital, where, unlike video, there?s no picture quality loss when duplicating. And studies show is that there?s a hard core element of consumers -- somewhere in the vicinity of 13 percent -- who readily admit on the phone they will frequently try to make copies of packaged media, videocassettes or whatever. Not everyone in the country does that, but when you look at 13 percent of them and look at the potential displaced revenue studios would lose by people making a copy and then not going out and either buying a sell-through cassette or renting something from Blockbuster, that number comes to in excess of a quarter of a billion dollars in the U.S. alone.

If you just compare that to just price we charge for copy protection, it?s something like a 20x return.

Strong patents

Who are your competitors?

In the video space there are none. We have very strong patents on our technology in the video space. Many companies and people have tried to come up with an alternative technology. The trick with the technology is to have strong enough copy protection that it upsets the VCRs but not so strong that it upsets the TV picture when you?re legitimately viewing the picture and not trying to make a copy. It turns out that?s a very difficult engineering challenge.

What about competitors in the digital area?

Our main "competition" in pay-per-view is Canal Plus in France. They?re not actually a competitor ? they?ve just chosen not to copy protect their networks.

There is competition for the copy protection solution for next-generation digital recorders ? which, as opposed to DVD players, aren?t on the market yet. These recorders require a whole new copy protection solution called watermarking which we?re in the process of developing. We?re competing against a consortium led by IBM
IBM, +0.70%
to be the standard in this industry. We have teamed with Digimarc Corp., a small private company out of Portland, Ore., and with Philips
PHG, +0.37%
the large Dutch conglomerate, and between the three companies we have 15 patents that we think are very strong and very controlling patents in the watermarking space. An ad hoc industry standards body will decide on this standard by the end of this year, and we think we?re in a very strong patent position going in because the other group, among them, only has one published patent.

You mentioned earlier you?re in computer software copy protection.

With computer software, specifically CD-ROM games or applications, there are now very inexpensive CD-ROM burners or recorders available for under $200 that allow you to copy audio CDs or any computer program or any game you want. The phenomenon caught the industry by surprise because it was not too long ago when those CD burners were actually up in the $500 to $1000 range.

We knew we wanted to expand our rights protection past video, and so we looked around and found a company in the UK called C-Dilla which has come up with a proprietary protection technology that buries the signature on the disc itself and doesn?t require you to do anything to the PC hardware.

We bought 20% of C-Dilla and got the exclusive rights to market their technology in the consumer multimedia space. We recently announced an agreement with Electronic Arts, the world?s largest interactive entertainment software company, which will use this protection product.

Acquisitions

Is that a strategy of yours ? to develop new technologies through acquisition or partnership versus R&D?

Yes. If you look at our financials we?ve spent just a couple of million dollars a year through our R&D, which is about 10% of our revenues. We?re talking to companies with new ideas and technologies, particularly as we move to copy protection over the Internet.

What are your plans in the Internet area?

We?re looking become a consolidator or aggregator of technology that will protect the distribution of programs on the Internet. The biggest Achilles heel of the Internet for software distribution is that once the application or program is transmitted over the Internet and downloaded to your hard drive there is no protection. We view that as one of the biggest challenges, biggest opportunities, we face.

C-Dilla is the first step in that direction, as this technology keeps you from copying programs on a hard disc and sending them over the Internet, but we think there are other pieces of technology we can put together into kind of a systems solution. The technology in the Internet space is moving so fast that if we were trying to hire people in and do development programs, we?d never be able to keep up with the pace. We think one of our core strengths is our ability to license technology and make use of our very strong customer base among some major rights owners -- and we want to definitely leverage off of that.

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